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Over the last few days there has been some panic selling of income paying closed-end funds by retail investors, and this often provides good opportunities. Once the current swoon is over, investors will still be looking for decent income streams with lower than normal volatility and interest rate sensitivity.

Because of the Federal Reserve's quantitative easing policy, nearly all traditional low risk, low volatility investments like T-Bills, CD's and money market accounts currently have extremely low yields near zero. But at some point interest rates will start moving higher, especially if our national deficits are not closed after the upcoming fiscal cliff discussions in Congress.

If you are willing to take on some credit risk, the First Trust High Income Long/Short Fund (FSD) is a good way to earn a higher return from a hedged low duration fixed income portfolio. The fund invests a majority of the assets in a diversified portfolio in US and foreign (including emerging market) high yield corporate bonds rated below investment grade at the time of purchase.

The fund's long positions, either directly or through derivatives, may total up to 130% of the managed assets. The fund's short positions, either directly or through derivatives, may total up to 30% of managed assets at the time of investment.

FSD is a fairly new closed-end fund that started trading in September 2010. The primary objective of FSD is to provide current income with a secondary objective of capital appreciation. One interesting feature of FSD is its hedging strategy. Unlike most other fixed income closed-end funds, FSD gets its leverage by selling short US Treasuries. These were the short positions in the last quarterly holding report.

FSD Short Positions (as of July 2012)

  • 2 Year Treasury: 16 million par value (coupon= 0.25%)
  • 5 Year Treasury: 103.2 million par value (coupon= 0.88%)
  • 10 Year Treasury: 27.5 million par value (coupon= 2.00%)

FSD has had good performance this year. Even after the recent price swoon, the NAV is up over 19% year to date.

FSD is currently selling at a discount to NAV of -7.36% compared to the 52 week average discount of -3.11%.

Asset Class Breakdown (as of 09/30/2012)

Corporate Bonds and Notes

71.5%

Foreign Corporate Bonds and Notes

20.9%

Senior Floating Rate Loans

3.7%

Asset-Backed Securities

1.7%

Common Stocks

1.1%

Other

1.1%

Here are some other stats on FSD:

Ticker: FSD First Trust High Income Long/Short Fund

  • Total Assets= 818MM Total Common assets: 682MM
  • Annual Distribution (Market) Rate= 9.15%
  • Last Monthly Distribution= $0.1335 (Annual= $1.602)
  • Fund Expense ratio= 1.29%
  • Discount to NAV= -7.36%
  • Portfolio Turnover rate= 18%
  • Weighted Average Credit Rating= BB-
  • Weighted Average Duration= 3.45 years
  • Effective Leverage: 21.3%
  • Average Daily Volume= 129,000
  • Average dollar Volume= $2.25 million

Overall, I think FSD is a pretty good value at its current discount, especially in a tax deferred retirement account. When the Fed starts to raise interest rates again, the US Treasury short positions should help its relative performance and provides good diversification benefits with other funds.

Source: First Trust High Income Long/Short CEF Is On Sale